Thoughts From the Divide – Lessons Learned
“Clearly it’s a topic of discussion”
If the saying is that we’re always fighting the last war, Chair Powell and his Fed comrades appear to be shellshocked. Not so long ago, when asked about where the FOMC’s collective thinking was, Mr Powell went with the rather cumbersome formulation “not thinking about thinking about” rate hikes. This time around, when asked about the various ins and outs of potential rate cuts, Powell said point blank that “the next question… is when it will become appropriate to begin dialing back the amount of policy restraint that’s in place… that’s really the next question, and that’s what people are thinking about and talking about”. He went even further, confirming that “when will it become appropriate to begin dialing back the amount of policy restraint in place… [was] also a discussion for us at our meeting today”. On the details of that discussion, the Chairman explained that “you’d want to be reducing restriction on the economy well before 2 percent because – or before you get to 2 percent so you don’t overshoot”.
Markets understandably took this as an unequivocal indication of rate cuts next year and moved quickly to adjust prices. Cuts? Try four by the end of next year. Stocks? To the moon. Regional banks were up more than 5% on the day. And long-dated yields dropped to the lowest levels since the summer. That there was a bull (ok, technically a steer) running rampant through Newark Penn Station yesterday seems oddly fitting.
Admittedly, while this may have left some commentators giddy and anyone brave enough to be short on the receiving end of an epic rally, it was perhaps presaged by the “queen of coo”, Janet Yellen, whose stint at UST has only burnished those credentials. In an interview with CNBC ahead of Powell’s presser, Yellen not only displayed her excellent sales skills, “I don’t think there’s any reason for investors to feel nervous about issuance”, but also dropped the following hammer. “As inflation moves down, it’s in a way natural that interest rates should come down somewhat because real interest rates would otherwise increase, which can tend to tighten financial conditions. But, you know, they have two risks to manage: one is that inflation doesn’t come down toward their target as they envision, and the other is that the economy becomes too weak. And I’m going to leave that call to them.”
So, in addition to giving credence to Waller’s mechanical argument (which Powell offered the rather neutral clarification that while real rates “is something that we’re very conscious of and aware of and monitor”, it “really is broader financial conditions that matter”), Yellen left the cynical among us seeing a gentle nudge. “Do the right thing, Jerry!”
It’s quite striking that the volte-face surprised even professional Fed watchers like Nick Timiraos, who noted, “What a difference two weeks can make”. Some might say that Powell crumpled like a cheap lawn chair (and not in a precise way), but that’s not our style. But unsurprisingly, some of the more cynical commentators wondered what had prompted the apparently abrupt shift. Some, like this commentator, questioned whether the Fed had seen something which had spooked them. Others chalked the move up to the election cycle (naturally echoed by Zero Hedge, which we hope we will be forgiven for referencing but does contain some good excerpts from the NYT on the much-maligned William McChesney Martin). Like the weatherman and banks we referenced a few weeks ago, has the Fed seen something that is terrifying it to the point of cowardice, or is it as simple as a bit of coordination with Pennsylvania Ave? One team, one dream, and after all, most public servants would agree that the Orange man represents a clear threat to democracy.